The papers in this volume were prepared as background for a conference on the major
macroeconomic issues facing the member countries of the Association of South East Asian
Nations (ASEAN), held in Jakarta, Indonesia, on November 7-8, 1996. The conference
aimed
to review the macroeconomic record of the ASEAN countries, examine the factors that have
contributed to the region's economic success, and identify the policy agenda for sustaining
this success into the twenty-first century. The background papers review the major policy
issues and add to the empirical evidence in key areas such as saving, investment, and the
current account; monetary policy, financial liberalization, and capital market development;
and the medium-term outlook.

This overview section provides some background on the region, summarizes the papers, and
conveys briefly the main points of the discussion at the conference.

Background

The ASEAN countries--Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore,
Thailand, and Vietnam--stand at the center of the most dynamic economic region of the
world, and their performance has been part of the Asian "miracle" that has been well studied
by economists and policymakers the world over. The region accounts for about 7 1/2 percent
of the world's population and a rapidly growing share of world output.

The economic achievements of the countries in this region over the past quarter century have
little parallel. As a result of strong, sustained economic growth since 1970, Singapore has
now
joined the ranks of the rich industrial countries, while Indonesia, Malaysia, and Thailand
have
seen their real per capita incomes rise more than threefold over this period (Table 1). More
recently, the Philippines, too, has seen its growth rate rise closer to that of the other countries
in the region.

Table 1. GDP Growth and Per
Capita GDP in Selected ASEAN Countries

GDP Per Capita (in 1996
U.S.
dollars)

Real GDP Growth annual average; in
percent)

GDP Per Capita (in
1996 U.S. dollars)

1970

1971-79

1980-89

1990-96

1996

Indonesia

338

7.8

5.3

8.0

1,119

Malaysia

1,503

8.1

5.8

8.7

4,652

Philippines

663

6.3

2.0

2.7

1,179

Singapore

3,328

9.1

7.3

8.3

31,787

Thailand

658

7.1

7.4

8.8

3,116

Industrial
countries

11,551

3.4

2.7

1.9

27,078

Western Hemisphere

2,752

6.2

2.3

2.7

3,530

Sub-Saharan Africa

541

3.4

2.9

2.5

332

Sources: International
Monetary Fund, World Economic Outlook: A Study by the Staff (Washington,
various
issues); and IMF staff estimates.

In much of the region, this rapid growth has also been accompanied by dramatic reductions
in
poverty. Thus, Malaysia has been able to virtually eliminate the incidence of poverty, while
Indonesia and Thailand have also made substantial progress in this key area (Figure 1).

An outstanding feature of the region's economic success has been exceptionally high saving
and investment rates that have shown increasing disparity with the rest of the world. The
strong and rising saving performance has reflected contributions from both the private and
the
public sector. In addition, these countries have been able to tap successfully additional
foreign
savings to complement their already formidable domestic effort.

Although countries varied considerably with respect to starting conditions, natural
endowments, and individual experiences, there is broad acceptance of the key policy settings
that have contributed to the region's strong economic fundamentals:

Third, careful government interventions in a number of areas--such as the antipoverty
programs--unleashed a powerful virtuous circle of government spending (especially on
education and health), productivity, and growth that helped ensure the economic and
political
sustainability of the reform process in these countries.

Finally, at least one other distinguishing feature of ASEAN experience has been crucial
to maintaining these policy settings. The willingness of these countries to adjust policies
flexibly and quickly in response to changing economic circumstances and challenges
allowed
a rapid transformation of the economic structure while maintaining intact strong
macroeconomic fundamentals.

Recent Challenges

In recent years, in the wake of the globalization of international financial markets, the
ASEAN
countries have faced major new challenges. The nature of these challenges and their impact
on
macroeconomic performance in the region were some of the issues considered in Indonesian
Finance Minister Mar'ie Muhammad's opening remarks at the conference, as well as
in
IMF Managing Director Michel Camdessus' address (Chapters 2 and 3).

As a result of these challenges, especially the interaction of large capital inflows with strong
domestic demand, external current account deficits have risen in the region well above the
average of previous years, and pressures on private sector credit and domestic prices have
also
mounted (Table 2). Greater attention has been given to the increased risks associated with
rising external deficits, especially in the context of the openness of the economies in the
region and the mobility of international capital. Although many of the region's traditionally
strong underlying economic fundamentals--such as the fiscal position and domestic
saving--have generally remained intact, there has been some erosion in other indicators and
greater volatility in exchange markets. For example, the recent slowdown in exports has
raised
concerns over exchange rate policy and competitiveness in some countries, and high rates of
credit growth together with property market developments have put pressure on financial
systems.

Sources: IMF, World Economic Outlook: A Study
by the Staff (Washington, various issues); and IMF staff estimates.1All ratios are in percent of GNP, unless otherwise indicated.2For 1996, December 1996 over December 1995.3Includes errors and omissions.

Thus, the macroeconomic policy mix in the ASEAN countries has come under increased
scrutiny, and the search for a strategy to reduce risks and sustain the region's exemplary
performance has intensified. Mr. Camdessus' address points to a number of ingredients of
such a strategy, including increasing domestic saving rates, reducing the burden on monetary
policy through the adoption of an ambitious approach to fiscal consolidation, increasing
flexibility in exchange rate policy, strengthening banking systems, promoting greater
transparency, and fostering good governance in the affairs of the state. These issues were
major themes of the background papers as well as of the discussion at the conference.

Savings, Investment, and the Current Account

Jonathan Ostry's paper on current account imbalances in ASEAN countries assesses
the sustainability of the widening current account deficits in the region in the 1990s. Using a
consumption-smoothing model, Ostry examines whether current account deficits (through
1994) have reflected excessive external borrowing for consumption, that is, whether foreign
saving has been used to finance consumption beyond what would be warranted by transitory
fluctuations in domestic income. His conclusion is that this has not been the experience of
the
ASEAN region and that the deficits have primarily reflected high levels of investment rather
than excessive private consumption. Nevertheless, Ostry stresses that reducing current
account deficits over time will minimize risks from other factors that bear on the assessment
of sustainability by financial markets.

Papers by Geoffrey Bascand and Assaf Razin, on Indonesia's fiscal position,
and by Philip Gerson and David Nellor, on the Philippines' fiscal policy,
develop a number of criteria for assessing fiscal sustainability in these countries, analogous
to
the sustainability criteria for external current account deficits. The papers conclude that
fiscal
positions are sustainable in both these countries; for Indonesia, Bascand and Razin reach
their
conclusion after adjusting for the exhaustibility of oil reserves and with reference to an
assessment of government net worth. However, the papers find that additional fiscal
consolidation would be prudent to strengthen external sustainability in both countries, as
well
as to reduce their vulnerability to external shocks.

The paper comparing saving performance in Southeast Asia and Latin America, by
Anuradha Dayal-Gulati and Christian Thimann, reinforces the conclusion of
the other papers, namely, that fiscal policy plays a key role in determining national saving
rates given that public saving in the region only partially crowds out private saving. Their
paper also provides extensive empirical evidence of the strong contribution that
macroeconomic policies have made to the high levels of private saving in the ASEAN
region.
However, Dayal-Gulati and Thimann also caution that policy measures to raise private
saving
typically work over the long term, hence providing additional justification for a larger
contribution from public saving in the near term.

The Philippines' Gabriel Singson, in his lead presentation at the conference, focused
on many of these issues, in particular, the sustainability of external deficits in the ASEAN
region, the appropriate balance between fiscal and monetary policies, and the scope for fiscal
policy to make a larger contribution toward reducing these deficits. Singson, drawing on the
Philippines' experience, emphasized the linkages between fiscal and monetary policies and
saw dangers in a policy mix that relied too heavily on monetary policy for current account
reduction. He pointed to the importance that tax reform had played in the Philippines in
lending credibility to the overall macroeconomic adjustment process, highlighting that this
had required strong political leadership.

During the discussion, Indonesia's Robby Djohan emphasized the considerable
importance that financial markets attached to current account sustainability. Djohan viewed
export growth, the composition of import growth, the structure of capital inflows, the
credibility of the exchange rate, and the level of reserves as being important factors
governing
the risks associated with external deficits in the region. He emphasized that policymakers
could contribute to sustainability by ensuring that policies were transparent, implementation
was consistent, the private sector was given a dominant role, and trade and investment
policies fostered openness.

Both Thailand's Somchai Richupan and Indonesia's Dono Iskandar focused
on
the importance of fiscal policy in the mix of measures to reduce current account deficits.
Iskandar noted that fiscal adjustment in Indonesia also had to contend with the declining
importance of oil revenues and that this had required tax reform efforts, the strict
prioritization of expenditures, and the provision of a greater role to the private sector in
infrastructure development. Richupan pointed, in addition, to reforms designed to improve
revenue collections at the state and local levels in Thailand.

The IMF's David Robinson provided additional background on the determinants of
private saving in the region, noting that, in the short term, dependency ratios would continue
to fall in a number of countries in the region, which should help boost private savings. He
said
that a supportive macroeconomic environment, the maintenance of competitive returns on
financial saving instruments, and the development of fully funded pension schemes were
promising avenues for increasing private saving in the region. However, because their effects
were likely to be felt only with relatively long lags, Robinson saw fiscal policy as the most
effective tool for raising national saving and reducing current account deficits in the near
term.

The discussion focused on both tax and expenditure policies as ways to increase public
saving. Many speakers judged that improvements in tax administration and tax collection
systems could make a strong contribution. Some speakers pointed to the still low ratio of tax
revenue to GDP in the region--considerably below that in many other countries--and saw
revenue increases through expanding tax bases and more efficient tax administration as
important channels for raising public saving. With respect to government expenditure, there
was agreement that policymakers would have to carefully weigh important competing claims
for additional spending on physical and human infrastructure rather than on other activities.
Speakers also saw a role for developing stricter criteria to evaluate the returns on public
sector
investment and for developing a more supportive environment for private sector
participation.

Two of the background papers examine the substantial changes that have taken place in
financial and capital markets in the ASEAN region since the early 1980s and their
implications for the financing of economic activity and the conduct of monetary policy.

Robert Dekle and Mahmood Pradhan's paper on financial liberalization and
money demand in ASEAN countries reviews empirical evidence that points to continuing
instability in the relationship between money growth, economic activity, and inflation. Their
analysis suggests that policymakers need to look beyond the behavior of monetary
aggregates--to a wider set of monetary and real sector indicators--to assess monetary
conditions. Their paper reviews the feasibility of alternative policy frameworks, such as
nominal income targets and inflation targets, and suggests that policy credibility would be
enhanced by greater transparency in the making of monetary policy decisions.

Tim Callen and Patricia Reynolds, in their paper on capital market
development and financial deregulation, look at these issues from the additional perspective
of
the financing of economic activity in Malaysia and Thailand. They find that rapid investment
and growth have been associated with a shift in corporate financing from internally
generated
to externally generated funds, consistent with trends elsewhere in the world. Callen and
Reynolds underscore the need for close monitoring of future developments and trends
affecting corporate leverage ratios, the growth of domestic bond markets, and changes in the
composition of bank loan portfolios, as part of effective monetary management.

John Montgomery's paper examines the impact of financial liberalization on
Indonesia's financial system. It reviews the general experience of financial liberalization in
other countries and points to the potential for such liberalization to result in the increased
risk
of poor lending decisions by domestic banks. Montgomery identifies key policy issues that
should provide the focus for further improvement of the performance of financial markets
and
institutions in Indonesia. These include the need to resolve rapidly the problem of
undercapitalized banks, improve the supervision and regulation of banking and securities
markets, and deepen and expand the competitive structure and domestic investor base of
these
markets.

The recent surge in capital flows to many developing countries, particularly in Asia and
Latin
America, has been associated with widening current account deficits and concerns about
exchange rate appreciations. Peter Montiel's paper on exchange rate policy and
macroeconomic management in ASEAN countries examines the impact of the large-scale
capital inflows on the real effective exchange rate in the region. Montiel finds that, unlike in
Latin America, the recent capital-inflow episode did not result in an appreciation of the
long-run real effective exchange rate in the ASEAN countries. The equilibrium rate
appreciated in Singapore after about 1987 and in the Philippines after 1990, but stabilized or
continued to depreciate in Indonesia, Malaysia, and Thailand. Montiel does not find
evidence
of misalignment in the real exchange rates of any of the countries in the sample at the end of
1994. He therefore concludes that the performance of the real effective exchange rate in
these
countries can be interpreted as broadly consistent with long-run equilibrium over the period
reviewed.

Many of these themes were discussed extensively at the conference, especially the
implications of structural changes in the financial environment of the ASEAN countries
(including for monetary and exchange rate policy), and the impact on domestic financial
systems. Indonesia's Soedradjad Djiwandono, in his lead presentation, pointed to
instabilities in the relationship between money growth, economic activity, and inflation,
caused by structural changes, that resulted in monetary policy in Indonesia being conducted
with reference to a broader range of financial variables. The Philippines' Amando
Tetangco said that the same instabilities had stimulated the development of a form of
inflation targeting in the Philippines, which had incorporated flexibility with respect to
capital
inflows and indicators of financial deepening. Tetangco said that the regime had worked well
so far, with generally low inflation, less variable and declining interest rates, and a stable
exchange rate.

With respect to the exchange rate, Soedradjad noted that the increased mobility and size of
international capital flows had also complicated the conduct of policy. He pointed to the
recent greater flexibility in Indonesia's exchange rate--a crawling exchange rate band--as an
attempt to address some of the difficulties posed by capital inflows and give greater control
to
monetary policy. Malaysia's Zeti Akhtar Aziz focused on the impact of increased
short-term capital flows on monetary policy and emphasized that an independent monetary
policy required flexibility in the exchange rate regime. However, Zeti pointed out that the
level of the exchange rate was also important, with policymakers facing the dilemma of
allowing the exchange rate to adjust partly or fully to short-term flows. She pointed to the
risk
of overshooting in this process, noting that the exchange rate was more volatile than was
desirable. Moreover, given the costs of, and limits to, sterilized intervention, Zeti observed
that administrative controls on short-term capital flows remained a temporary option in
certain
circumstances.

The discussion placed considerable emphasis on the importance of sound domestic banking
systems, with Soedradjad stressing that weaknesses in financial institutions translated into
additional constraints on monetary policy. A number of speakers echoed this point, with
Thailand's Bandid Nijathaworn discussing the range of policies needed to safeguard
financial systems in a rapidly changing environment. Nijathaworn emphasized, in particular,
the strict enforcement of capital adequacy requirements, close monitoring and continuous
assessments of banking system vulnerability to capital flows (both inflows and outflows),
and
the potential need for measures designed to discourage the banking system from extending
excessive credit, as well as the importance of a strong fiscal position as an anchor in a
volatile
financial environment. Based on the region's experience, Nijathaworn also stressed that
financial liberalization should be undertaken gradually and cautiously to give the monetary
authority and financial institutions time to adjust.

Picking up on this theme, the IMF's John Hicklin also discussed the increased risks
to
the banking system as a result of financial liberalization and capital market development and
agreed with Nijathaworn that steps should be taken to minimize these risks. Hicklin
emphasized the importance of greater exchange rate flexibility and the need to deal quickly
with emerging nonperforming loans. In this context, country authorities needed to
demonstrate
a greater willingness to close failed banking institutions in the context of improved
prudential
regulation and to work toward more transparency in indicators in line with the strength of
financial systems. Hicklin noted that supervisors would need to focus increasingly on the
ability of banks to assess market risks, including those associated with derivative positions.

Medium-Term Outlook

The background papers for the final session of the conference, the medium-term outlook,
deal
with ASEAN in a regional perspective, as well as with future growth and productivity trends.
The paper by Jeffrey Frankel and Shang-Jin Wei reviews regional aspects of
ASEAN performance, including the role of trade and foreign investment in fostering the
region's remarkable record of economic growth and the prospects for sustaining its rates of
growth of trade above the world average. Frankel and Wei find that these prospects will be
helped by a number of factors, including continuing rapid productivity growth--which will
be
spurred in part by further trade liberalization as well as by the full integration of the
transition
economies of Southeast Asia with the rest of the world.

The high degree of external openness of the ASEAN economies is also considered, among
other influences, in the paper by Flemming Larsen and Jahangir Aziz, in the
context of comparing the ASEAN business cycle with that of the industrial countries as well
as looking at the future growth convergence of the ASEAN countries. The paper finds some
evidence of a decoupling of the business cycle in the ASEAN countries from that in the
industrial world, attributable in part to the growing dynamism of intraregional trade and
other
economic interactions. Regarding convergence, a significant degree of "catching up" by the
ASEAN group with the industrial world has already taken place--although with considerable
diversity in experience among ASEAN countries. On the basis of current trends, the paper
concludes that the average income level in the ASEAN countries will reach Japan's 1995 per
capita income level by the year 2010.

Michael Sarel's paper on growth and productivity reviews the sources of growth in
the
ASEAN economies, in particular the role played by total factor productivity, taking as
background some recent studies that have concluded that growth rates of total factor
productivity in Asian economies have not been nearly as spectacular as their growth rates of
output. Using an alternative methodology and database, Sarel finds that total factor
productivity growth has indeed been impressive in several ASEAN countries and that the
proportion of output growth per person attributable to such growth is not systematically
different in the ASEAN economies and the United States.

The final session of the conference, featuring a roundtable of speakers from the ASEAN
region and the IMF, focused on the medium-term economic outlook. There was widespread
agreement that the outlook for ASEAN countries would continue to be positive provided that
macroeconomic management remained flexible and prudent, economic policies remained
market oriented, and recent pressures on financial systems were addressed swiftly. In
addition,
sustaining the growth of total factor productivity over the medium term will require
increased
investment in infrastructure and education, with a greater role for the private sector in these
areas.

The IMF's Jack Boorman reviewed the basic paradigm for growth, distilled from the
experience of the ASEAN economies, as well as the new challenges in a more globalized
world. Both Boorman and Malaysia's Tan Sri Datuk Clifford Herbert cautioned
against complacency, noting that international acceptance of the basic paradigm was
relatively recent.

Tan Sri Datuk Herbert stressed, in particular, that balanced budgets needed to be
complemented through an acceleration of privatization programs, especially in new areas,
such as health and education. Provided that sufficient regulatory safeguards are in place, the
private sector can play a much bigger role in these areas. At the same time, to sustain
high-quality growth, government expenditure should be directed more toward human
resource
development, research and development spending, and the social needs of the poor. In the
area
of governance too, there should be more private sector participation in the decision-making
process. This would help promote efficiency and professionalism in the public sector and
instill confidence in the system of governance by limiting corruption. In this context,
Boorman also pointed to the need to eliminate off-budget outlays and increase the
transparency of fiscal policies; improve data dissemination; strengthen banking supervision
standards; and eliminate institutional mechanisms such as indexation that may entrench
inflation and inflation expectations. In many of these areas, Boorman said that the IMF was
prepared to play an important role through technical assistance and increased surveillance
efforts.

Boorman also urged policymakers in the region to disseminate their experience to other
developing countries, noting that there remained some reluctance in parts of the world to
accept the ASEAN region's basic paradigm. He noted that the ASEAN countries could
provide valuable policy advice and technical assistance, especially to countries in Africa, on
macroeconomic management and on how to limit the distortionary effects of state
intervention. Within ASEAN, this paradigm was also under attack in some quarters, but for
the wrong reasons. Insufficient attention to strengthening institutional capabilities, especially
in the area of tax administration, had created new problems, such as crime and money
laundering, that needed to be addressed.

The growing demands for finance for infrastructure development had not, according to
Japan's
Yukio Yoshimura, received sufficient attention. Given the constraints on public
finances, there was an expectation in the region that the private sector would increasingly
fund
infrastructure projects, but thus far domestic saving had not been channeled toward
infrastructure development. Promoting the development of bond and equity markets in the
region would help increase private sector funding for infrastructure and lessen the fiscal
burden. Private finance would also bolster efficiency, and foreign financing would speed up
the transfer of technology from industrial countries. However, governments will need to
guard
against the adverse effects of large private capital inflows on exchange rates and on
monetary
policy and maintain a competitive pricing and regulatory environment to ensure that projects
are funded on the basis of market criteria. Yoshimura emphasized the necessity for
cooperation in the international community and, in this regard, appreciated the IMF's role in
monitoring macroeconomic developments.

Singapore's Teh Kok Peng emphasized the longer-term requirements of sustaining
growth in the ASEAN countries, particularly those related to maintaining the quality of
factor
inputs. Although much of the recent debate on East Asian growth has centered on the growth
of total factor productivity, in particular on the Krugman claim that its growth had been
negligible (and, in some cases, such as Singapore, negative), Teh suggested that
policymakers
should not be overly concerned about growth that was driven largely by factor accumulation.
Rather, the challenge ahead was to ensure that adequate funds were devoted to human
resource development. The ASEAN countries compared well with the newly industrializing
economies with respect to the percentage of the population enrolling for primary education,
but lagged considerably behind with regard to secondary and tertiary education. Currently, a
number of countries in the region, such as Indonesia and Malaysia, are experiencing skill
shortages in key sectors, especially in engineering and computing, in part reflecting the lower
levels of enrollment in higher education compared with Japan and the newly industrializing
economies.

The sustained improvement in economic performance in Vietnam over the past ten years has
been helped by its membership in ASEAN and by its greater integration with the region.
Vietnam's Le Dang Doanh reviewed recent economic reforms in Vietnam,
emphasizing that, while much remained to be done--especially maintaining the momentum
in
the transition toward a market economy--prudent macroeconomic management had helped
reduce inflation and boost exports and overall economic growth. Saving in Vietnam
remained
lower than in other ASEAN countries, and this would limit the pace of infrastructure
development and spending on education and health. The government was eager, however, to
encourage a greater role for the private sector in these areas. Le Dang Doanh was confident
that the continuing efforts to reform the legal framework and promote the development of
financial markets would further enhance economic performance over the medium term.

The IMF's Flemming Larsen emphasized the growing importance of ASEAN in the
world economy and the changing nature of trade and financial linkages between those
countries and the industrial countries, key themes in his background paper. Whereas during
the 1970s and 1980s business cycles in ASEAN countries moved closely with those in the
industrial countries, since the late 1980s, growth in the ASEAN region has been less
influenced by fluctuations in economic activity in North America and Europe. Larsen cited a
number of factors that had led to the decoupling of business cycles between ASEAN and the
industrial world, including the sustained increase in trade, both intraregional and with other
developing country regions, and the countercyclical nature of capital inflows from industrial
countries. Moreover, current trends in per capita income growth in the ASEAN countries
suggested that--like Japan and, more recently, the Republic of Korea--the ASEAN countries
were making rapid progress in converging toward industrial country living standards.

*Note: John Hicklin is Assistant Director, David Robinson is Division
Chief, and Anoop Singh is Deputy Director in the IMF's Asia and Pacific Department.